Performance Bond Underwriting Requirements

Construction contractors new to surety bonds are often wondering exactly what are the performance bond underwriting requirements the surety company is looking for when they review financial statements. We will start start with the most common considerations.

Working Capital –  Current Assets less Current Liabilities.

• Current assets are cash and assets that expect to be or could turned into cash within one year. These usually include include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and underbillings. The surety underwriters will make adjustments to some of these numbers. For instance, most surety bond underwriters will not accept prepaid liabilities (prepaid insurance is the most common) as a current asset. The underwriters will likely adjust down the value of any inventory. Receivables over 90 days old may also be discounted.  The surety will also take a long look at the underbillings as often underbillings are is a sign of future profit fade. The surety bond underwriting financial considerations will always take a conservative approach to financial analysis.
• Current Liabilities are liabilities that will most likely come due within one year. These include accounts payable, current portion of long term debt (the amount of a long term loan dues in the current year), overbillings, accrued liabilities (accrued interest expense, accrued wages, or accrued services), notes payable, and outstanding balances on a bank line of credit.

While each surety company may few working capital differently, a good rule of thumb is working capital should be at least 5% to 10% of the current cost to complete of all jobs. this is found on a work in progress schedule.  For example, adjusted working capital is $100,000, that should support a back log of cost to complete of $1mm at a 10% working capital ratio. The performance bond underwriting requirements are somewhat subjective as well. Positive working capital made up of a high percentage of cash will carry more weight than working capital of mostly accounts receivable. For emerging contractor, the SBA surety bond guarantee program may be an attractive alternative to the standard underwriting companies.

Net Worth – Total Assets less Total Labilities

This performance bond underwriting requirement is simple to understand. Net worth can be considered a good gauge to the ability of a construction company to absorb a loss. Like adjustments to working capital, the surety company underwriters will make adjustments to the analyzed net worth. Intangible assets, like goodwill, or intellectual property will be deducted from the net worth calculation.  A portion of inventory, accounts receivable over 90 days, and the value of unsettled claims,  are examples of downward adjustments the surety will make to net worth. A general rule of thumb, net worth should be 10% to 20% of the cost to complete on all open jobs.

Other Performance Bond Underwriting Considerations

Surety bond underwriters thrive on ratios. The financial ratios can only be as good as the information reported. Internally prepared financial statements or financial statements prepared by an outside bookkeeper will not carry the same weight as financial statement prepared by a construction oriented CPA firm. Also, there are different levels of CPA prepared financial statements. A review quality statement will be better than a CPA compiled financial statement. Having a working capital line of credit with a bank is a positive attribute as well.  For the SBA bond guarantee program, the SBA will even consider an unused bank line as available working capital. Other performance bond underwriting requirements, including those not of a financial nature can be found here.  

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More Articles on Performance bond Underwriting

• Performance Bond Underwriting Guidelines
• What are Underbillings?
• What are Overbillings?
• What is Profit Fade?
• What is a Work in Progress Schedule? 
• Levels of CPA Financial Statements